Tuesday, March 20, 2012

To give you a better illustration of my point, let’s use Bill Mitchell’s favorite analogy (with due respect) of the buffer stock of heads of cattle. But in this case, let’s use a recurring income transaction of selling milk, which is what would be more closely similar to a wage income stream. Imagine an economy with 1,000 heads of cattle, owned individually by different farmers, all of whom are each other’s customers for the milk. Let’s imagine that each cow can only provide for one customer at a time, each of whom buys a long-term milk stream, say for 5 years.

Now, imagine 200 farmers want to save, so there is demand for only 800 milk streams. This decreases the price of milk, which was say, $100/one year’s delivery, down to $80/year. But then, imagine that a default buyer arrives, and makes an open offer of $100 /year for each undemanded milk stream, thereby increasing total demand back for all 1,000 heads of cattle, and price back to $100.

This default buyer increases the income stream, and therefore, the ‘animal spirits’ of the cattle owners, and they then start demanding other milk-based products. Milk duds, milkshakes, and chocolate milk start becoming a common craving of the now better-off famers. Let’s say 50 farmers now require more than one cow, because they want to expand into these milk goodies, bringing the farmer end user demand to 850 heads.

But since the default buyer keeps his open demand of $100 for all undemanded cows, not all cattle owners are willing to provide his cow to the other farmers now willing to buy more than one cow’s milk stream. Some farmers just got accustomed to the default buyer’s arrangement, perhaps because he is more convenient to transact with. So to attract some of the 200 providing their cows in service of Mr. Default Buyer, these 50 farmers up their offer to $110/year.

30 farmers willingly transfer to the new buyers, leaving 20 more without a cow for their additional demand. Let’s say and additional 10 were willing to pay for up to $115, which entices more farmers to shift, but still leaves 10 new owners unable to make their expansion. 840 cows are now providing milk for other farmers, 160 remain Mr Default’s suppliers.

Now, the farmer cum customers are getting even more prosperous, and demand even more milk-based products. Milk bonbons, cream pies, and designer ice cream now become the “new cool products” to have. This entices more producers to come forward, as the profit margins for these can accommodate the now $115 clearing price for one cow’s year of milk, and then some. Let’ say 80 farmers come forward offering $125. This entices 50 of the 160 remaining suppliers to Mr Default to shift.

That still leaves 30 new producers unable to find suppliers for their new bonbon business. Of those already serving other farmers, 20 indicate they’re willing to transfer again at $145. So 20 of the 30 get their cows, but 20 other farmers that already had cows lose theirs, and the price to get new cows starts at $145. Meanwhile, the 110 that still remain with Mr Default stay with him.

Now what happens when milk-based pastries, cream cocktails, and milk sauces become the norm? Bidding for the remaining 110 cows, or for any of the others willing to transfer from some other farmer customers, probably starts at $170. Maybe Mr Default still will 80 cows left afterwards, but cow inflation has now risen 70%. Time to start tightening.

Just because you put a floor on a price for something does not tell you anything about how high its price will go. Not when you only have a finite supply of that thing. And when someone puts an open offer for all of the supply, the bidding starts higher and proceeds more furiously, whenever there's an expansion of general demand, than when the open offer is withdrawn when other offers are coming to the table.

addendum: Geerusell asks a good follow-up question: “Why are farmers who supply Mr. Default presumed to be so sticky at the $100 level?” - It could be any reason in my mind. He’s easier to deal with, he doesn’t give hell when the cows want to take a cow holiday, is willing to accept a more flexible schedule, work is closer to home…a lot of other reasons. But I can imagine not everyone offered the first higher price will immediate jump on it. A sizeable number won’t jump until.. they’re made an offer they can’t refuse.

Hi Matt. I know what you're asking. No, there's no credit or government deficit funding in my story, which is only about a little community, which you could think of as part of a larger economy that has those things . The chief focus is on how wage bidding happens when there's a default buyer, not on where additional currency comes from. Mr. Default is the JG in this little community.

"So to attract some of the 200 providing their cows in service of Mr. Default Buyer, these 50 farmers up their offer to $110/year. "

So wouldnt these 50 farmers who now would want to pay the 110 need 50 x (110-100) = 500 of balances to be able to pay for the milk? Would not this have to be borrowed?

If so, then consider that it is not the JG but the govt monopolist price setter again, that ratifies the new 110 price in the economy because the govt (in the form of a bank) does the loan deal at the 110...

Alright, if you insist on putting the currency increase in this analogy, let's make this community the representative economy.

That means farmers who want to pay more for cows are able to by borrowing the money. The additional credit increases the money going around for more consumption.

Mr Default is able to issue his own currency, and therefore never needs to borrow. That's how he can make a blanket demand for any and all undemanded cows any time.

This still doesn't make a difference to the main point. Mr. default's continued presence in the expansion makes the wage bidding more intense, simply because not all farmers are willing to shift from Mr default at the same price. The price needs to keep getting higher to get those with higher tresholds to shift.

That means farmers need to borrow more to bid more. Of course, if more production leads to more income and more consumption, then they could keep borrowing more. But again, this point is for another post.

Quotation marks were cited by "Some Guy" over at Bill Mitchell's, citing Randy Wray. I'm adding it here to add my response to those as reinforcement to the points I made in this analogy.

"just as workers have the alternative of BPSE, so do employers have the opportunity of hiring from the BPSE pool. This is the primary ‘price stabilization’ feature of the ELR programme. If the wage demands of workers in the private sector exceed by too great a margin the employer’s calculations of their productivity, the alternative is to obtain BPSE workers at a mark-up over the BPSW. … The ELR pool will operate as a ‘buffer stock’, and just as a buffer stock of any commodity can be used to stabilize its price, the government’s labour ‘buffer stock’ will help to stabilize the price of non-BPSE labour to the extent that workers in the ELR pool are substitutes for non-BPSE labour.”

No business can fire workers in order to get cheaper workers from the JG, that's illegal. Not even if employers are pissed off that workrs are asking for higher wages, they can't just replace them. Neither can their workers just ask for higher wages, not unless they either see that the economy is improving, or their company is increasing its profitability.

If the overall economy is indeed improving, then there will be wage inflation, because many businesses will be hiring workers, not just one or two. And as I said, if there's a JG blanket demand for everyone, then the more workers needed by private businesses, the higher wages will go.

Now if it's only their specific company that's increasing profitability, then that company is likely increasing the wages of its best workers on its own accord. Many well-run companies will seek to reward those that work hard to make them successful, and so not lose them to other companies. So if this company's wages are going higher than other companies, then other workers will want to join it too, whether they're from the JG or other companies. The JG doesn't really buffer down any wage for anyone, unless the overall economy is not improving, or a specific company is not improving.

"If the ELR pool is not as effective in stabilizing wages as unemployment has been, then the number of workers in the pool will have to be greater than the number of unemployed in order to have the same wage dampening effect. If 6 million unemployed are required for price stability, then perhaps 8 million ELR workers will be required. ..is it better to have, say 6 million unemployed or 8 million employed in ELR? .. We believe the answer to the first question is obvious… ”

This statement reinforces my point about the business killing effect of a JG program that also has a price stability mandate.

"That means farmers who want to pay more for cows are able to by borrowing the money. The additional credit increases the money going around for more consumption.

Mr Default is able to issue his own currency, and therefore never needs to borrow. That's how he can make a blanket demand for any and all undemanded cows any time. "

I follow you here...

So to break it down, system achieves equilibrium state 1 (ES1) when the 200 cows are idled.

Mr Default comes in and disrupts the ES1 equilibrium by purchasing the idle 200.

System transitions to a NEW equilibrium state ES2 with all cows employed. Everything is fine again and in equilibrium ES2.

Now, "animal spirits" come in to disrupt this equilibrium state ES2, with certain agents desiring to pay more which disrupts ES2, not the actions that upset ES1 (JG).

They go to the government (bank), and get a loan for the addl balances needed to settle the 50 transactions at 110. IT IS AT THIS POINT THAT GOVT RATIFIES THE NEW PRICE STRUCTURE BY APPROVING THE LOAN WHICH UPSETS THE EQUILIBRIUM ES2. It doesnt have anything to do with the initial govt action to upset equilibrium ES1; these are independent actions.

So you have 2 independent govt actions, 1 action to employ the unused resources which upsets ES1, 2nd action to ratify a new higher price structure by granting loans to certain agents who desire to pay more for the 50 cows which upsets ES2.

One can perhaps mis-apply a direct causation between the events around the upset of ES1 leading to the upset of ES2 because one follows the other, but I can see no direct causation.

I agree with this. Price instability is much more about credit expansion than base money. The keys to price stability are much more about maintaining a steady interest rate & regulation of the asset side of banks balance sheets so that credit expansion doesn't get out of control, whatever that means. The cow price guarantee does, however, provide a much better floor than no cow guarantee, so it's really just one element of price stability, rather than the whole milkshake.

Why are farmers who supply Mr. Default presumed to be so sticky at the $100 level?

They came to Mr. Default originally because the alternative was zero. When the alternative becomes a $115-$125 market clearing price why would any farmer prefer the $100 offer?

I argue they wouldn't. Once the defection price has been discovered it will be a plateau where every new offer that comes along gets filled at that price by one of Mr. Default's suppliers.

The tipping point (no cow pun intended) where bidding pressure resumes is when Mr. Default's stock is exhausted. At this stage, the sky is the limit. However it's not Mr. Default frothing up the milk market, he's out of the picture now.

Matt, I know you’re trying to say something with “IT IS AT THIS POINT THAT GOVT RATIFIES THE NEW PRICE STRUCTURE BY APPROVING THE LOAN WHICH UPSETS THE EQUILIBRIUM ES2. It doesnt have anything to do with the initial govt action to upset equilibrium ES1; these are independent actions” but can you expound on the main point?

Why is it government who approves the bank loan?

Geerusell asks “Why are farmers who supply Mr. Default presumed to be so sticky at the $100 level?”

It could be any reason in my mind. He’s easier to deal with, he doesn’t give hell when the cows want to take a cow holiday, is willing to accept a more flexible schedule, work is closer to home…a lot of other reasons. But I can imagine not everyone offered the first higher price will immediate jump on it. A sizeable number won’t jump until wages rise much much higher, and eventually they’re made an offer they can’t refuse.

I imagine the same goes for some people when they have a choice between going back to the private sector when offered, and just staying in a JG program. This creates a bottleneck vs a smoother flow from JG to private sector. The higher bidding not only ends up getting people out of the JG, but just to keep people their existing people, businesses need to pay up too.

Good job on the ‘cow’ puns btw, I only had cow farmers and their ‘animal’ spirits. Looks like you milked that pun for all it’s worth.

It gets back to what Warren says to paraphrase: "prices are a function of what the govt directly pays for things or what collateral requirements it places on it's banking partners who lend against things..."

There is further info about "inflation" from the MMT paradigm here:

http://mikenormaneconomics.blogspot.com/search?q=infaltion

In your cow analogy, the entrepreneurs that want to pay 110 would probably get 80-85 against the milk they buy itself, and then have to post NFAs from previous savings for the other 25-30 in order to secure the loan.

Then to be able to sell the milk derivatives at a profit may require another loan for the consumers... and on and on, and this would not depend on the JG, but rather whether agents could get the loans imo.

Matt, agreed that government spending affects the price level, but bank lending is a whole separate matter from the government-spending induced price level inflation that you mention. Despite the fact that government spending can induce general price inflation that also leads to wage inflation, it's not as direct to wage inflation as a permanent JG.

It doesn't lead to the conclusion that government approves all bank loans. Unless you're talking about government-owned banks, these are approved by private banks that stand to lose capital if they make wrong lending decisions. It's an act, as I'm sure you know, that's not affected by the amount of reserves in the system.

Be careful in using this line of argument as some wiseass anti-government people might use that point to justify the bogus argument that government spending is responsible for all inflation.

This discussion allows me to ask a few questions that have been in the back of my mind. :)

First, why is it that in a wage-price spiral, wages get the blame? IIUC, in a barter economy there is no problem with real wages. If so, what is the problem with effective real wages in a money economy (through indexing)? Also, in a barter economy, are wages not assumed to be enough to sustain life, or do economists assume that some people starve to death as a normal occurrence? If they do not make that assumption, why the opposition to a sustainable wage in a money economy? I get the impression that some of the assumptions of economists are anti-labor.

In regard to a job guarantee, is that not like Friedman's idea of a guaranteed income, except that those receiving that income are not idle? The job guarantee yields a minimum wage, and, like current minimum wages, it would tend to increase other wages. Considering how a major problem in the developed world over the past four decades has been that wages have been too low, wouldn't that be a good thing?

Min, so many questions, not sure if they're related to my intended point in this post, but let's try to give it a go.

"First, why is it that in a wage-price spiral, wages get the blame?"

My best guess is someone who blames wages would be someone who focuses on demand, and how demand is affected by income.

"in a barter economy, are wages not assumed to be enough to sustain life, or do economists assume that some people starve to death as a normal occurrence?"

Not sure what your question is here, but wouldn't it be that in a barter economy, there are no wages? People may starve in this case, but it won't be because of lack of wages, it would be because of lack of demand for what they are bartering with.

"If they do not make that assumption, why the opposition to a sustainable wage in a money economy?"

You'd have to ask the economists opposed to it, I wouldn't want to put words in their mouths.

"In regard to a job guarantee, is that not like Friedman's idea of a guaranteed income, except that those receiving that income are not idle?"

Yes, i have the same impression.

"Considering how a major problem in the developed world over the past four decades has been that wages have been too low, wouldn't that be a good thing?"

My position is that a livable income for more people is what the system needs. A sustained wage spiral is different, though, since monetary increases that do not go hand in hand with real goods increases only makes the price of real goods more dear.

If a bank starts to lend $1M against mobile homes, then govt examiners/regulators come in and review these loans; if said examiners then approve of these loans, the price of all mobile homes quickly becomes $1M.

Please go back to the link at MNE above and forward to the 13:00 mark in the video there and Warren, Bill, and Randy shred on the MMT paradigm wrt so called "inflation".

Matt, again agreed that government examiners review bank activities, but it's the banks themselves who decide whether to approve a million dollar or not, not the examiners. All the examiners really have to know is that the bank knows what it's doing and that it has the capital to absorb losses from that million dollar loan. No examiner goes and tell the bank you have take back that loan, or not to give it out in the first place. No examiner sits on any bank credit committee.

To give you an analogy, just because the government places a fence on the most dangerous parts of the Grand Canyon doesn't mean that there are no fall because of that fence. Most reasonable people already know to keep away from the most dangerous parts of the canyon. There are exceptions of course, but that doesn't mean it's the fence responsible for everyone's decision to go on the edge.

I watched that clip you sent, and nothing in that clip gives me the impression that MMT economists are saying government is responsible for bank lending decisions.

And again, is MMT really saying government spending is responsible for all inflation (and deflation)? That's the implication if you say it sets all prices in the economy. That doesn't seem right. It's something monetarists would more likely say.

Matt, I checked your last link, and lending in this context refers to the increased Fed swap lines to the ECB during the height of the last Euro crisis. It was central bank to central bank lending, so yes it pertained to 'banks'. And yes, at the central bank level, which can issue as much of the currency as it wants, its decision to issue and lend it to foreign economies, which depreciates the dollar against their currencies, determines how much 'inflation' or loss of purchasing parity there is in the economy.

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.